Author: rickandrade121

10 WAYS TO BOOST YOUR COMPANY’S VALUE

Practice #10: Review your Capital Structure

As you may know, Capital Structure is how a business finances itself using debt, equity, or other securities like bonds, etc. The key question I am often asked is “what is the best capital structure for my business?” The answer in part depends on which industry you are in, and if you are a ‘mature vs growth’ company in that industry. In either case it is important to make sure you are operating within typical industry guidelines for debt vs. equity ratios of comparable firms. If most companies in your industry have 40 percent debt on the books and you have 70 percent debt, your valuation could suffer even though your cash flows can meet interest obligations. Bankers, buyers and investors love to see standard metrics balanced across debt vs. equity in order to compare your firm’s future prospects with best in class companies in your industry.

As a result, business owners at all levels that try to maximize shareholder investment, do so generally by reducing their “Cost of Capital” which means that Debt as opposed to Equity is cheaper to finance operations and growth. The cost of debt is the interest rate, while the cost of equity is harder to calculate (using CAPM etc) but is generally the expected return your investor would have of a similarly risky venture. In most cases, making an illiquid investment in a middle market private company is considered a more risky investment, hence higher expected return (rate).

The easiest way to see this in action is to compare several types of funds by their costs of capital expected rates. Dozens of studies and analyses can be found that identify the cost of various capital options. One analysis by Robert Slee, professor of finance atPepperdineUniversitydelineated several types of capital you can choose from and the expected rates of return associated with each in the chart below.  The chart includes typical costs of capital for Bank Loans, ABL (Asset Based Lending), Mezzanine Lending, Private Equity, Venture Capital, and Factoring as of June 2011:

As you can see, with the exception of Factoring, the cost of capital (expected return rates) increases as business owners move from lower cost bank lending on the left side to higher priced equity and venture capital investments on the right. Of course all companies want a lower cost of financing, however, while equity requires no monthly interest payments, the overall cost of selling (issuing) equity is higher. Hence the ideal Capital Structure is some combination of debt and equity. And by maximizing the cost of capital for your company you can improve the overall valuation of the firm.  Conversely a lop-sided Capital Structure can reduce the value of your company when compared to a more efficient competitor in the industry. 

If you don’t know which type of investment is best to fund your company, it is always best to consult with your commercial and investment banker for advice. Let them run the calculations for your specific firm lay out the options.  Remember; your target Capital Structure should be similar to industry benchmarks or better if possible.

10 WAYS TO BOOST YOUR COMPANY’S VALUE

Practice #9: “Breed” new products

Most companies have cut R&D over the past few years to save money; however, this can be a losing strategy over the long term. Even one new successful product, if launched properly, can have lasting positive effects on company valuation. You don’t have to have the next Apple iPad up your sleeve, but “signaling,” or creating the impression that you are continuing to develop new products sends an important message to the market, competition, staff, and future investors who expect continuing innovation.

In addition, because suppliers may also be looking for new business opportunities, consider developing new products with suppliers as a combined R&D team effort.  Working with suppliers in R&D not only combines lower cost with better supplier relations; it also signals confidence internally and externally to retailers and customers that your business isn’t sitting around waiting for demand to improve.

Typical R&D budgets for an industrial sector company average 3.5 percent of sales, while high tech companies can start at 7 percent of sales and biotech firms can reach 40 percent or more. Having no R&D budget, on the other hand, is not only the kiss of death for the future, but also signals to everyone (including bankers, suppliers and customers) that your company is a one-product venture, and may not be around in the long term.

The consequences of no R&D translates to lower enterprise value, lower margins and lower competitive advantage in the market. While you may not see the wisdom of an R&D expense budget today, by next year you may find yourself out-maneuvered as competitors seize new market trends ahead of your expectations and at the expense of your profits and your future. Becoming a “breeder” of well designed new products exemplifies a commitment to growth, and can lead to a significant increase in business valuation over your competition.

In part 10 we look at Capital Structure, and why it’s a key to your success.

10 WAYS TO BOOST YOUR COMPANY’S VALUE

Practice #8: Reduce COGS expenses

Rather than waiting for commodity prices to increase, take an overview of all your inputs to your cost of goods sold (COGS) per product. If you are a manufacturer, raw material price movements can dramatically affect profits from period to period. The way to win this battle and reduce COGS is to focus on the following:

• Raw material input flexibility
• Strong supplier relations
• Process automation

Raw material input flexibility means you have tested new, cheaper raw material inputs with customers and found a sustainable quality alternative. If you generally buy large quantities of raw materials from the same supplier, ask that supplier to investigate cheaper high quality substitutes and experiment with these to see what works with customers. If your supplier doesn’t seem to be on the same page, investigate getting another supplier. Also consider signing a supplier contract with stipulated pricing for discounts on volume, and term of the agreement.

Ideally you should have deep supplier relationships where both you and the supplier have a significant stake in the outcome should something go wrong or input prices increase suddenly. Any supplier not willing to work with you is pause for concern in reducing COGS going forward. In fact, it is a best practice to have at least three suppliers for every key input material of COGS, enabling you to keep each one honest, productive and competitive when it comes to serving your needs.

Finally, consider your relative competitive position when it comes to process or “throughput” automation. This is the speed and cost of producing or completing a single product or service sale. Since capital costs are down in this economy, consider funding new equipment that can increase throughput substantially, reduce bottlenecks and gain a competitive edge going forward. Even though investing in capital projects in an uncertain economy is daunting, with all things considered, now is a good time to take advantage of equipment manufacturers’ and service providers’ discounts and financing, before a renewed consumer confidence increases prices.

Check in for part 9 on boosting company value by investing wisely in R&D.

10 WAYS TO BOOST YOUR COMPANY’S VALUE

Practice #7: Institute a means to track financial performance ratios

As banking relationships for middle market companies migrate from “rosy” to results, it’s important to know where you stand financially in the eyes of your bank in order to avoid a catastrophe. Here’s what I mean. Since the economic crises began, banks have been quietly tightening and restricting credit terms on nearly all their products, including lines of credit and Sr loan facilities. Unfortunately, many businesses did not become aware of the situation until it was too late. Many suddenly found themselves in violation of loan covenant terms or worse, cancelled exactly when they needed the money most.

To best know where you stand, the first thing is to call your banker and reconfirm the terms of your borrowings. Find out what has changed, and what metrics are being tracked more closely if you don’t already know. There are dozens of performance ratios that middle market businesses track monthly, and you can find most of them and their respective formulas here. http://highperformanceorganizations.net/FinancialRatios.pdf

However, from a bank lender point of view there are only a few key metrics generally in the form of written loan covenants they need to see regularly including: 

1. Profitability – EBITDA (cash flow)
2. Leverage – Debt to Equity ratio
3. Liquidity – Current Ratio and Quick Ratio
4. Working Capital –  Current Assets minus Current Liabilities
5. Debt Service Coverage Ratio – Cash to cover interest payments

Of course, there are dozens of other performance and solvency metrics to calculate depending on your industry, banking and borrowing terms. In the past year, many businesses took too long to figure out what they needed to do in advance in order to meet the performance metrics for their bank. If you know sales are down don’t wait to contact your bank. Find out what can trigger a default and how to mitigate any adverse reaction beforehand if possible.

You should also compare your ratios to your competitors. You can find ratios for over 10,000 lines of business at www.BizMiner.com and you can use the calculators at www.Bankrate.com to get things started. Over the longer term as you grow consider as a best practice investing in a software solution that can automate and forecast business ratios quickly and easily, giving you time to react before a problem arises. And by showcasing that you are ahead of the game when it comes to transparently managing your business performance, you can increase the value of your business as compared to others that don’t.

Coming up in part 8, we will talk about reducing COGS expenses.

10 WAYS TO BOOST YOUR COMPANY’S VALUE

Practice #6: Reduce overhead expenses

 One bright spot of the economic downturn is that it has forced many companies to look more closely at where overhead SG&A expenses are being spent. This is not simply headcount, but other indirect costs as well. The key metric to benchmark in a review of overhead expenses is how they compare to that of similar competitors.

 In an overhead review you should look for how well you have empowered managers to cut costs in each department and how well your company communicated guidelines and rules to enforce a discipline and structure to validate and verify overhead spending per department. There is a very good whitepaper from Kaiser Associates (http://www.kaiserassociates.com/wp-content/uploads/SGA-Optimization-Whitepaper_06.02.08.pdf) on SG&A issues to consider and how to structure your organization to better manage and control overhead.

 SG&A is not easy to reduce without first studying the impact on other functions of the business. The key point is to understand how SG&A drives profitability and then to establish benchmarks to measure progress each period. As many as 90 percent of companies who institute SG&A cuts, fail to sustain their cost-cutting three years after the cuts were implemented. The reason is that after sales and profits improve, many companies let new costs creep back into the mix. A best practice is to retool your company culture and develop a savings mindset that penetrates all areas. Encourage staff to think of costs as their own personal ROI value to your bottom line, rather than as benefits, perks and corporate freebies they deserve.

 Middle market and smaller companies can implement a cost conscious culture more easily than larger firms simply because of the personal touch smaller business owners can display in their own actions.  Employees want to see management is “walking the talk” when it comes to sharing the pain so to speak.

 Employee Stock Ownership Plans (ESOPs) have also been shown to increase employee awareness of expenditures for SG&A and to profitability when effectively implemented. If you would like to see how ESOP’s can work for you check out the ESOP Association: (http://www.esopassociation.org/about/about_association.asp).

 The bottom line on reducing SG&A expenses is to give every worker a stake in the outcome. Reward them for creating new ways to reduce costs and developing, over time, a culture that emphasizes thrift over spending. You will know you are on the right track when an employee asks “why are we spending money on this…”

 In part 7, I look at financial performance ratios.

10 WAYS TO BOOST YOUR COMPANY’S VALUE

Practice #5: Review your marketing and advertising ROI

 According to advertising analyst firm Outsell, most companies spend 50 percent of their advertising budget on their website. Whether that is a good thing to do may depend on your industry.

 The key question is; how much can you afford to spend to get a sale? Few executives actually know the answer to this question because it is a complicated mix of variables, given the recent emergence of Social Media and the growing number of online advertising channels linked to Google search. What you need to ask yourself is, what is your advertising Return on Investment (ROI) per advertising media channel, or more specifically, where can you get the biggest bang for your buck (print, tv, radio, mobile, or on-line)?  And the answer is not a mystery anymore.

 The first place to look is at your competition. What are they doing right? And how are they doing it? Then, focus on identifying both your anticipated advertising ROI for the year, and learn how best to measure it.  Advertising Spend as it’s called in the Marketing Mix, is a percentage of total sales. If you don’t know your industry Ad-to-Sales-Ratio you can find it online, and here http://www.saibooks.com/adv-ind-sector-ratios.html

 If your annualized Ad-to-Sales ratio is out of line with industry norms then you best explain why or else. Many companies spend too much on advertising without knowing how effective it is, and some say 50% of all advertising is wasted.

 There are many software solutions in the Customer Relationship Management (CRM) space that can calculate ROI per channel for you. These systems can save thousands in mis-guided ad and marketing expense by tracking ROI from lead generation, campaign management, social media and response rates for tv, print & mobile ads. Even better, most CRM solutions are outsourced, and sold as (SaaS) Software-as-a-Service, meaning the software is licensed as a service online and charges a monthly fee.

 Once you have a system in place you can then reduce costs and increase profits by identifying and specifically targeting the most cost effective (ROI) channels for your money. And who wants to say no to that these days?

 In part 6, we look at reducing overhead expenses.

 

10 WAYS TO BOOST YOUR COMPANY’S VALUE: Practice #4: Do an IT system checkup

Have you ever counted the number of computer programs you access each day? If you think about it, the fact that each employee can touch several software systems every day can be a serious waste of time and efficiency. Once a planning tool for manufacturers, enterprise resource planning (ERP) systems have become a necessary operating strategy for most businesses. While many middle market companies do not need all the capabilities of a large enterprise ERP system, they do need to know why they don’t by investigating and pricing the available best-in-breed systems used by competitors,

An IT system review and tune-up is a key success factor that needs to be done at least once a year by a team of cross-department heads lead by an IT systems pro who knows what competitors are up to in your industry.

They begin by listing each department’s business requirements and compare that to what your systems currently track and don’t track. A wide gap between the data and reporting you need to see and the time it takes to gather the information means you are losing money and you should look for new software or updates to narrow the need and reporting requirements. The goal is a narrow gap, which means you should be as profitable as you can be with the latest information at your fingertips.

As 2012 ushers in a wave of new outsourcing IT options based on “cloud” computing, which is the outsourcing of hardware and software to a trusted third party vendor offsite.  The advantages can reduce your current and expected costs of buying, operating and staffing a growing IT department.

By having a more comprehensive information technology program, you can reduce other indirect costs as well, such as CPA/audits, tax preparation, financing and inventory carrying costs, while increasing the value of your business to potential buyers and investors down the line. As IT costs continue to grow, make sure you are considering all the options, and, getting the most value from what you have now.

An IT system review can do that for you.

In part 5 of this series I’ll discuss boosting your bottom line by reviewing your marketing and advertising ROI.

 

10 WAYS TO BOOST YOUR COMPANY’S VALUE: Practice #3: Re-evaluate your supply chain

Another way to increase efficiency and save money is by analyzing supply chain purchases and implementing an e-procurement solution. E-Procurement systems have matured in the last decade and today offer many ways to connect in groups and save money on volume purchasing.

Joining a volume purchasing organization can reduce raw material costs, streamline purchase processing costs, and reduce or eliminate “rough spenders” in your company by electronically restricting their purchases to pre-approved vendors.

If you’re in the Food & Bev industry, for example, Foodbuy manages over $5 billion in volume purchases for the foodservice and grocery industry and passes the savings on to its members. Other industry trade groups do the same. You can find specific volume purchasing opportunities in most industries nationwide.

Lastly, the importance of key-input supplier relationships cannot be overstated. Most firms depend on a single key-input supplier as the lifeline in their supply chain. If that supplier goes under or raises prices or treats you poorly, however, there’s little you can do. The consequences can ruin your business and your hard earned customer relationships quickly.

To avoid this, you must find and nurture more than one key-input supplier. Go to trade shows in your industry. There you will likely find eager alternative key-input suppliers. Work with them, explain what you’re up to and work out a trial period.  Investing in secondary key-input supplier as a lifeline back-up within your supply chain is a best practice worth every penny when the time comes.

In part 4 of this series I’ll talk about doing an IT system checkup.

10 WAYS TO BOOST YOUR COMPANY’S VALUE: Practice #2: Reduce and Refocus Your SKUs

Many middle market companies took a big hit in the market downturn when they were left with previously well-selling inventory sitting on shelves longer than expected. This is a key warning sign most of you already know well. The best practice here is to rebalance your stock-keeping unit (SKU) mix and focus more on higher profit margin products until things improve.

Many companies hesitate to reduce high volume, low margin SKUs because they don’t want to cut back on anything that sells and contributes to positive cash flows. But you need to look at the longer-term analysis of total costs and capacity utilization. Total costs include inventory-carrying costs such as direct warehousing and storage, transport and logistics, indirect selling, general, and administrative (SG&A) overhead, and financing costs, among others. Often the results are surprising and now more than ever you should be compelled to compare high margin versus low margin products and channels on a spreadsheet each month.

In addition, there is evidence that higher-end consumers are increasing their purchase behaviors faster than lower-end consumers. According to a study released in 2010 by Bain & Co., “High-end retailers, home sellers and car dealers are all experiencing an uptick in business” coming off a historically bad 2009. If your products can cater to an upper-income crowd, focus more on them.

Hence, your strategy should not be to simply try and wait it out for your lower-margin customer segments to return, but rather you should meet those who are still buying with new, high-end, high-margin products, thus creating a relative SKU re-balancing in your product portfolio.

Stay tuned for the next tip on re-evaluating your supply chain!

10 WAYS TO BOOST YOUR COMPANY’S VALUE: Practice #1:  Reduce Customer Concentration

One of the first practices to boost your company value when sales aren’t growing is to look closely at your customer concentration (CC) levels.

Customer concentration warning signs occur when any business has sales or accounts receivable in excess of 15 percent (of total sales) from a single customer.

While in many cases 15 percent seems a low risk, many financial institutions, including banks, investment funds and even the SBA, will question you in order to understand the trend and go-forward risk if you should lose that customer at some point.  High CC businesses risk higher interest rates, and a potentially lower corporate valuation. A valuation downgrade or discount can affect your future expansion or sale plans more than you might expect, and who needs that these days, right?

One of the easier ways to reduce high CC, obviously, is to spread annual sales across a wider customer base. Try to incentivize your sales team to add new accounts, not just to increase sales from older ones. And while trade shows are the perennial stalwart for increasing accounts, be sure to develop a webinar and social networking channel strategy to expand your geographic coverage. I have clients who are expanding customer accounts internationally using webinars and social networking tools.

In the event you simply can’t find a way to reduce high CC, try to create as many layers of protection between you and the key customer as possible by signing multiple term and product contracts with staggered expiration dates. This, in effect, spreads your sales across a wider group of buyers inside the account such that no one buyer can pull the plug with the stroke of a pen or phone call. This strategy can help protect larger accounts from walking away by breaking them up into smaller contract pieces. Make sense?